Impact investing and Islamic finance

Can we invest with the goal of making profits while also creating social value?

Gulf News

Impact investing, as defined by the Global Impact Investing Network (GIIN), is the investment made into companies, organisations and funds with the intent to create positive social and environmental impact, alongside financial returns. Arguably, Islamic finance is, therefore, very well-positioned as a framework for impact investing due to its underlying ethical principles and moral considerations. The reality, however, is that the majority of Islamic investment firms have largely focused on negative screens (e.g. nature of business, revenue sources and indebtedness of target companies) rather than bringing about positive social impact (e.g. greater accountability towards the environment and fair labour market practices).

‘Impact investing’ is an investment strategy that seeks to resolve the questions: “Can we invest with the goal of making profits while also creating social value? Can we solve some of the world’s most pressing social problems through business? Can development impact coexist with profitability?”

Depending on who you speak to, the answer may range from a resounding ‘No’ to an absolute ‘Yes’. Although opinions vary, there is a plethora of investment funds targeting both financial returns and social impact.

Impact investments target financial returns that range from below market (sometimes called concessionary investments) to risk-adjusted market rates, and can be made across asset classes; including fixed income, venture capital and private equity. The size of the impact investment market has been estimated at $77.4 billion (Dh284.29 billion) according to the GIIN 2016 Annual Impact Investor Survey. Pioneers in this field have ranged from specialist investment firms, such as Acumen Fund and the Omidyar Network, to large foundations, such as the Ford Foundation, Bill & Melinda Gates Foundation and The Rockefeller Foundation.

Sustainability has become a huge buzzword and even global investment firms, such as Goldman Sachs, JP Morgan and Blackrock, have jumped onto the bandwagon with their own impact investment platforms. Although impact investments have caught on globally, the GCC region has lagged behind in the development of this emerging investment strategy.

Wide ranging impact definitions

Most impact-focused investments are formed around generating “positive” social impact, with specific goals such as increasing agricultural yield or reducing infant mortality. This can usually be achieved through small- to medium-sized investments in private companies targeting a particular social issue.

Public markets, however, bundle up impact investing with ethical investing (also known as Ethical, Social and Governance (ESG) Investing), which has a minor focus on “positive” impact but instead relies largely on “negative” screens when sourcing investments — for instance, avoiding investments which rely on tobacco, alcohol, gambling, environmental pollution and other elements deemed harmful to society.

Some industry participants argue for placing priority on impact investing and accepting below market returns, while others argue that maximising returns in line with (or above) market should be of foremost importance, with social impact measured as a secondary priority.

Depending on how impact is defined, it is arguable that both are possible. In publicly-listed firms complying with ESG criteria, above market returns are more easily achievable than in private firms, where the inherent illiquidity — coupled with the early stage nature of most businesses — makes it much harder to achieve market-based returns and exposes investors to a higher risk of business failure.

GCC, Islamic finance, and impact investing

Islamic finance and impact investing are complementary — both occupy leading positions in the value-based investment universe, possess rigorous moral and social criteria and share a broader understanding of the relationship between capital and society at large. These similarities suggest a promising avenue for impact-focused Islamic finance. Given its inherently ethical nature and its developmental impact, Islamic finance should have been a pioneer in impact investing but the reality is that, thus far, it has lagged behind.

Progress is being made, however, as the Islamic Development Bank has recently announced the launch of the Global Islamic Finance and Impact Investing Platform (GIFIIP) with the United Nations Development Programme to work towards achieving the UN’s Sustainable Development Goals (SDGs).

An estimated $5-7 trillion in spending is required each year to meet the SDGs and this is where Islamic finance can play a big part. Islamic finance has grown from a market of $200 billion in 2003 and is expected to reach $2.7 trillion in 2021. Such a large capital pool represents a strong potential source of financing for the SDGs and can foster development and assist in poverty alleviation.

Immediately addressable are the needs of the Organisation of Islamic Cooperation (OIC) member countries, which account for 22 per cent of the world population but house 40 per cent of the world’s poor, who live on $1.25 a day or less. By widening and deepening the range of impact-focused Islamic financial solutions available to the poor, especially microfinancing, substantial progress can be made towards achieving the SDGs.

The GCC, being a hub of Islamic finance, can play an important role in the creation and growth of new Islamic financial institutions that have impact at the heart of their strategy. More awareness is needed to make Islamic finance leaders and GCC governments take note of this movement and consider how they can most effectively capitalise on impact investing to generate returns, as well as make a positive impact on society.

Mohammed Fahim Shelot, CFA, Member of CFA Society Bahrain

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